Sarine Technologies (SARINE SP) - New Drivers May Soon Emerge

3Q16 at low-end of expectations. Still a BUY

3Q16 net profit of USD4.0m came in at the low end of our expected USD4-6m highlighted in our last report. We deem this as a slight miss.

Still, 3Q16 is a strong reversal from the USD1.4m loss in 3Q15 while the 34% QoQ dip is largely due to a high base in our view. But margins were weaker than our forecasts because of product mixes and we cut FY16- 18E by 7-12% to adjust for that. This brings our DCF-based TP down from SGD2.01 to SGD1.97. Maintain BUY.

Broke last quarter’s record

Galaxy sales With 22 Galaxy-related systems delivered this quarter (2Q16: 20, 3Q15: 1), Sarine broke its last record of 20 units in 2Q16 and brought total installed base to 275 units.

Recurring revenue accounted for 40% of its 9M16 revenue. However, we note that the 22 units consist of 12 Meteors and seven Solaris which have a lower upfront fee than a Galaxy, therefore there was weaker lift to revenue.

Management also said that there were some uncertainties in the midstream in 3Q16, which dissipated only at the tail end of the quarter after a positive Hong Kong Jewellery show.

New invention, new drivers?

A key highlight of the analyst call however was about their new products that automatically evaluate and grade two key polished diamond parameters: Clarity and Colour. Clarity is currently evaluated almost manually and subjectively.

We believe that eventual contributions could be on a similar scale as its Galaxy products. But we think that given the slower-than-expected adoption of its Sarine Profile/Light/Loupe, investors are likely to discount this potential until greater earnings visibility.

Sarine expects some contribution as early as in FY17E but we have not factored it in.

4Q could at least match 3Q

We also note a very positive stance in their outlook statements which usually comes with some cautionary notes, but these were largely absent in their latest statements.

Our analysis in our last report also suggest robust industry conditions and therefore although 4Q is traditionally a weaker quarter due to the Diwali holidays in India, we think that it may match 3Q16 performance or better.

Swing Factors

Upside

Further penetration of its GalaxyTM family of machines, especially the SolarisTM that has only achieved 25% penetration while the MeteorTM is newly launched.

Sarine LightTM, LoupeTM and ProfileTM become widely adopted as an industry standard by retailers and gemlabs in measuring and grading polished diamonds.

Strong contributions and adoption of new automated Clarity evaluation and grading technology as well as new advanced automated Colour classification technology.

Downside

Margin squeeze on its rough manufacturer customers due to mismatch in rough diamond prices and polished diamond prices leading to tightened liquidity.

Earnings recovery fizzles off as customers hold back on capex and manufacturing activities for fear of weakening sales environment.

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